Wednesday, May 15, 2013

The European transactions tax -- an act of pure hope?

My latest column in Bloomberg came out about a week ago. Forgot to mention it. The story is this: The European Commission has very firm plans to introduce a financial transactions tax -- a "Tobin" style tax -- on most financial transactions at the beginning of January 2014. That's just over 6 months away. I was surprised to learn they were taking this step, as I thought that very little was really known about the likely consequence of such a tax, especially introduced on such a grand scale. So, I spent a week or so looking into all the research I could find on financial transactions taxes, theoretical and empirical, and came to the conclusion that -- indeed, very little is known. But Europe is going ahead anyway!

If anyone wants to look at some of the original research, I suggest having a look at the following few things. First, the best overall review is this one by Neil McCulloch and Grazia Pacillo of the University of Sussex. Their conclusion is, in two sentences, that...

We conclude that, contrary to what is often assumed, a Tobin Tax is feasible and, if appropriately designed, could make a significant contribution to revenue without causing major distortions. However, it would be unlikely to reduce market volatility and could even increase it.

But if you read the report, you'll see that the outcome seems very likely to depend on fine details of how the tax is implemented and of the markets to which it is applied.

Other important studies are this one by Westerhoff and Pellizzari which uses an agent based market model to test how the consequences of a transactions tax might depend on market microstructure. I think this is among the most sophisticated studies done to date (although it can still be improved in many ways and represents a beginning, not an end). There's also an older review from 1993 by Schwert and Seguin that I read and which is useful (sadly, I'm not sure where the link is.... I have a pdf and found it by googling, that's all I can say). Finally, if you have the brave heart to read the original impact assessment of the EC proposal for the tax, it is here. That report doesn't actually mention any research on how the tax will likely influence markets, but only looks at how the macroeconomy might be effected.